Speech

Alex Chisholm speaks about preparing for the digital economy

Speech given by CMA Chief Executive, Alex Chisholm, at the Institute of Directors Annual Convention.

Looking ahead: preparing for the digital economy – view from the new competition regulator

Good morning and thank you to the Institute of Directors (IOD) for the chance to speak with you here today.

As the regulator on the otherwise whizzy entrepreneurs panel, I fear the part intended for me may be to rain on your parade. But I don’t plan to do that. For one thing, I was once a digital entrepreneur myself, so I feel a lot of empathy and respect for what today’s digital entrepreneurs are achieving. But also because I represent the Competition and Markets Authority (CMA), the UK’s new national competition authority. And as a competition authority, we generally welcome all this digital innovation.

I am going to tackle the same question as the rest of the panel – ‘preparing for the digital economy’ – but do so from the perspective of a competition regulator.

Let me begin with a quote.

The internet is probably the greatest invention in the last century. It has had an impact on almost every aspect of our lives. We can now keep in touch, share information, and buy anything from a book to a swimming pool just with the click of a button. But does it come – like other good things – at a price?

So began my 15 year old son’s essay on the internet, which I read last weekend. I mention it because the two-edged quality of the internet is clearly something that any school child can appreciate. All that information – but how to know what can be trusted? All that free stuff to enjoy – but also all that monitoring of our behaviour. So much easier to keep in touch with friends – but also for our enemies to get together as well.

Today I want to explore this duality from the economics perspective of competition and markets. Then use that to sketch out what that means for the CMA as an institution, and to some extent, perhaps, for regulators as a class.

In competition land we like to see low-entry barriers, as this makes it easier for innovative new players to come into a market and challenge the established firms and practices. The internet has very low-entry barriers, in that anyone can offer their wares – and their views – to a potentially large audience, at little or no upfront cost. But it is striking how the most successful firms – in terms of market share and longevity – tend to be at the larger end of the spectrum. And that a mass of smaller firms do not make much if any profit. There are evidently tremendous economies of scale and scope and powerful network effects which are, for example, helping to bring ever closer Jeff Bezos’ vision of ‘the everything store’. I read that his original name for Amazon was ‘relentless’, and I like to think that this was not so much a self-characterisation as an intuition of how relentless these economies would prove to be.

We also like to see markets where it is easy for consumers to search for alternatives and to switch providers. In general the internet has made this very much easier. This has greatly extended the choices available to us as consumers, and put tremendous pressure on producers to offer us the keenest possible terms. But these great benefits have not been achieved without costs.

We get to do this free surfing around between millions of sites because they are mostly funded by advertising dollars (if they are funded at all). And digital advertising is in its way relatively undeveloped, in the sense that it is quite low value. One of the most successful digital advertisers, Facebook, says its users spend 40 minutes per day on the site, which equates to about 60 hours per quarter. Dividing the profit by the number of users, the profit per user is about 60 cents per quarter. Ie, the profit is about 1 cent per hour of use (1).

To try to improve the economics of digital publishing, we witness a seemingly inexorable drive to gather our personal data by internet companies. This has a positive side, in that it can help us receive more targeted advertising and better tailored service offerings. But not everyone appreciates all this aggregation of our personal data and observation of our online behaviour.

Many of the internet companies most active and powerful in this new domain of personal information go about their business very privately indeed. The US Federal Trade Commission did an interesting report in May this year which looked at the practices of 9 of these data brokerage companies: Acxiom, Corelogic, Datalogix, eBureau, ID analytics, Intellius, PeekYou, RapLeaf, Recorded Future. I wonder how many of you here in the Albert Hall have heard of any of these data broker firms? Few, if any, I suspect. But I bet they know plenty about us.

As data is passed on and repackaged by digital firms like these, does consumer consent get eroded?

There is another economic drawback to all this easy searching and switching. It is pricing data which proves most comparable, and most noticeable (or ‘salient’ in the jargon). And price certainly matters a lot. But so does quality. If we focus ever more on price we are likely to get more and more products and services that are cheap because they offer low value.

Take insurance. If you are an insurer or underwriter and you offer a policy that offers a high prospect of pay-out in the event the insured risk occurs, this will be more expensive than a policy with a mass of exemptions. And it may prove hard to sell this higher-quality product on a price comparison website, even if pound for pound – premium paid for cover provided – it offers better value. As value-seeking consumers we may enjoy the drive to the bottom, right up until the point at which we arrive.

The reduction in fixed costs made possible by digital distribution is another mixed blessing.

Reduced input costs and more contestability from potential new entry usually feeds through to lower prices and higher consumption by consumers. We can see many markets where consumers seem to have been under-served, and where less efficient intermediaries are now being seriously challenged by new digital players. What will be lost if some of these intermediaries go to the wall? Well, music and book publishers have historically played an important role in identifying and nurturing talent: has the internet really made this function unnecessary? Or will new firms provide this service? Or will the publishers themselves adapt and thrive?

Sometimes people say to me we are living through a digital era of Schumpeterian destruction. I nod wisely but I don’t pursue the point, never in truth having been quite sure what Schumpeter meant. But at least at a basic level, I do see the point that the prospect of unforeseen disruption to one’s future business viability – at the level of a firm or even a whole sector – is both bracing and alarming. As a competition authority, our mantra is to love competition, not competitors. Even so, it is possible that extreme uncertainty could be harmful for markets, especially those requiring large amounts of sunk capital investment – even if economic theory would hold that these risks can be adequately diversified. And we must recognise the possibility that market power built up in one market segment could be used anti-competitively to dominate another segment.

All this disruption also makes it more challenging to identify what are the market boundaries of competition (2). As entry barriers come down in the face of digital innovation, firms that once operated in distinct market sectors come now into direct competition, typically intensifying the rivalry. But the impact on competition will not always be favourable. Some of the new digital players may look to establish and exploit new sources of market power, perhaps through the use of data, or of essential technology, infrastructure or intellectual property.

And of course the duality of the internet is there in the wondrous convenience we experience in our digital lives – my son’s one click to purchase a swimming pool (a fanciful idea, by the way) – but also the unsettling vulnerability that we are beginning to recognise in our dependence on digital markets. Vulnerability to cybercrime and cyber warfare, either of which could suspend or corrupt online marketplaces on which we increasingly depend.

So, as regulators, how should we approach this two-edged instrument, the internet? Well, clearly, with some caution. We need to be:

  • vigilant, recognising that not all digital developments are for the good, new bottlenecks and new sources of market power can emerge, and we must be ready to confront new abuses where we find them
  • better informed and more digitally capable – and you can help us with that, at least by sharing your market intelligence with us
  • better coordinated, with other regulators, here in the UK and internationally, recognising how digital markets cross sectoral and national boundaries
  • more flexible and agile in the face of fast-changing markets
  • and properly humble – recognising that markets are generally self-correcting. Regulators can make things worse as well as better, and that most of what will be achieved for consumers will be through the innovations and efforts of firms like yours

If there was more time I could give some practical examples of how we are trying to play this part at the CMA. If you’re interested to research further, I am including links to 5 examples from our digital case portfolio below of these remarks.

So let me conclude now.

The internet is 25 years old but it is still in its adolescence. There is so much about it to ‘like’. But there are also some drawbacks and risks which we had better keep in sharp focus. At the CMA, we are up for that.

Further reading: Office of Fair Trading/CMA digital cases

Footnotes

(1) This example and these figures taken from an article in ‘The Atlanticist’ August 2014 by Ethan Zuckerman – ‘The Internet’s Original Sin’.

(2) Peter Thiel, co-founder of PayPal, discusses this point in ‘The Wall Street Journal’ 10 September 2014. Using the example of Google, he asks if the company is better thought of as the dominant player in the market for search, or as a small player in international advertising and consumer technology markets.